Salary Sacrifice or “Smart" pensions

Your gross pay goes down so you pay less National Insurance

Many employers are now using salary sacrifice schemes to reduce the cost of pensions. They are sometimes called "Smart Pensions".

A salary sacrifice scheme works like this;

• Employees' salaries are reduced by the amount of their pension contributions.
• Instead the pension contributions are paid directly to the pension scheme by the employer.
• There is a small saving for both the employer and employee in reduced National Insurance (NI) contributions, because the pay that appears on your payslip is lower.

As an example: someone earning £15,000 pa with a 6% pension contribution rate pays £900 pa into the scheme.

Using salary sacrifice their earnings would be reduced to £14,100 pa and their NI contributions would be reduced by £84.60 pa.  

The employer NI contributions are also reduced by a similar amount.

When salary sacrifice schemes first started, it was thought that the Government would move to close the “loophole”. However this has not happened. Either the Government are allowing it as an incentive for employers to provide pensions, or perhaps they recognise that as there have always been non-contributory pension schemes, introducing salary sacrifice is merely a change from a contributory to non-contributory scheme and therefore allowed under pensions law.

When should salary sacrifice be avoided?

If as a consequence of salary sacrifice, pay that was previously above the National Insurance Lower Earnings Limit (£84pw for 2006/7) drops below this level, then entitlement to a number of state benefits could be at risk.

These include

• Basic state pension
• Incapacity benefit
• Job Seekers Allowance

Salary sacrifice can also affect entitlement to the State Second Pension (S2P).

If you not a member of a company pension scheme or are a member of a “contracted in” scheme, then salary sacrifice will reduce the value of your S2P benefits. This is a complicated area, but people with gross earnings between £12,500 and £33,000 are likely to lose some S2P, and this could be higher the older they are.

What safeguards need to be put in place?

Overtime, shift pay, and other additional pay need to be calculated on the basic pay before the salary sacrifice is applied.

• In schemes where pension is directly related to final salary, this needs to be based on their pay before salary sacrifice is applied.
• The calculation of a refund of contributions, either if the member leaves or in the event of death in service, also needs to be safeguarded.
• Salary sacrifice schemes can fall foul of pension scheme rules if they put a cap on pension benefits. Before 2006 Inland Revenue rules set a limit on pensions linked to final taxable earnings. (In simple terms, pension could not exceed two thirds of final taxable pay). Those limits has now been removed, but some pension schemes have kept them in their rules, so that members cannot accrue a higher pension than two thirds of their final salary. These rules would need to be changed in order to reflect the use of salary sacrifice.
• If an employer is proposing to introduce a salary sacrifice option to a “contracted in” scheme, then they must advise members of the impact on their entitlement to State Second Pension.
• If the scheme is a defined contribution scheme, then there is a case to be made for the employer to put some of their NI savings towards extra pension contributions.

When can salary sacrifice not be used?

Salary sacrifice can not be used if it reduces pay below the National Minimum Wage.

Conclusions

Most employers will be aware of the issues covered in this briefing but it is important that they do not automatically put members into salary sacrifice schemes without safeguarding those who might lose out.

The safer option is for members to have to positively opt for salary sacrifice, rather than opt out. However many employers will want to operate an opt out policy, in order to maximize their NI savings.

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© 2003 (USDAW) Union of Shop, Distributive and Allied Workers
This page: http://www.usdaw.org.uk/pensions/resources/1170932968_19425.html
Last Modified: Friday, 09-Feb-2007 03:37:20 EST
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